It pains us to write about the fiscal cliff, but it permeates virtually every financial market. Since the Great Depression the popular Keynesian prescription has been to take countless shots of government spending and don’t worry about the morning. Well, don’t look now, but the sun is peeking above the horizon and the rooster is gargling.
It appears we have reached the Keynesian endpoint; not because capital markets have shunned US debt, but rather the political will to support more debt has dissolved. Make no mistake, if the US Treasury wanted to issue more debt it could do so easily and find a ready buyer in the asset hungry Federal Reserve. However, the framers of America purposely incorporated checks and balances in order to keep bureaucrats from diverging from the will of the people. By no means do we believe America’s populous is united, on the contrary, it is probably the most fractured in over 150 years. Those who voted for the President sent a clear signal that solving the debt and deficit time-bombs was a top priority…and so did those who voted against the President. The only difference is the method by which each group wants to solve the problem. Once a generation we ask our leaders to actually do something, collectively we have asked and we have requested austerity.
How much of our request will be fulfilled is still unknown – under the best case scenario our austerity will be served in a sippy cup, allowing the economy to slowly adjust, or…we could be forced to drink from a fire-hose. How our austerity is served has great consequence for
our economy and the financial markets. The most recent ISM manufacturing PMI indicated that the US economy is at stall speed and may even be contracting. Looking further into the the report we find that the New Orders Index plunged to levels not seen since the 2000 and
2008 recessions. We present this data not as our credentials for the doom and gloom club, but simply to show that the US economy is fragile and susceptible to shocks. The negotiations in Washington, DC are the proverbial butterfly flapping its wings, the question then
is – will we have a hurricane or just a light spring rain.
To be sure, austerity has its virtues, it can remove some larger flora so that new flowers can bloom. What’s more, in a global economy that is hyper-sensitive to debt levels, a credible path toward debt sustainability could restore the US dollar to the currency of choice for discerning reserve managers.
Pride in Manufacturing
A strong fiscal position could indeed attract investment into manufacturing in the US and a strong dollar would go a long way to creating a stable environment for capital expenditures. With Chinese wages rising at an average 14% per year and US wages stagnant there is an incentive for companies to begin to bring some jobs back. However, the other side of this coin is regulation, which appears to waxing not waning. In our view, any gain in competitiveness will likely be offset by increased regulation. Thus we are left with an economy that has tremendous potential but faces an uphill climb.
Stronger Political Ties
Not only is the country divided, but within one of the main political parties fractures have appeared. It remains to be seen whether Speaker Boehner has control of his party; with it he may indeed be able to reach across the aisle, without it one of America’s main political parties is a ship without a rudder. Financial markets crave certainty and stability and desire is something politicians understand. In our view, the month of December will be a minefield of press conferences, tape bombs and wild speculative moves. For our part, remaining cautious with plenty of dry powder is the proper stance.
The question then becomes who has the better future, an economy with fractured politics, entering austerity and on the edge of recession or an economy that has taken its medicine? Yes, the former is US, not Europe. The recent out-performance of European shares indicates the markets perception that in 2013 the future for Europe is so bright it will have to wear Gucci shades. This view finds its roots in the comparison of
PMI’s between the US and Europe. It appears that Europe is bottoming, while the US sits on the precipice of recession.
We are skeptical of a sustainable rebound in Europe as the deleveraging is still ongoing. Our view would change if we witnessed credible effort to induce growth in the Eurozone. On the other hand, the untapped potential of the American economy keeps us hopeful. Hopeful that politicians can resolve personal differences, hopeful that we get a sippy cup, and hopeful that our nascent economic recovery has not been mortally wounded.
The era of monetary stimulus is fading and fiscal austerity is gaining momentum. Sobriety brings clarity. It’s
morning in America, prouder and stronger and better?